Safeguard Your Portfolio Against This Huge Risk

Can your portfolio survive higher interest rates?

Few things about the state of the global economy seem certain these days. Between surging commodity prices, market crashes and rebounds, central bank interventions, sovereign debt crises, and political and social unrest in the Middle East, the past three years should have strongly reinforced the need to own a portfolio of investments with the ability to survive broad-market fluctuations. With the flames from the financial crisis mostly smothered, and the economy slowly improving, many of the most crucial macroeconomic questions seem resolved. However, a few major pitfalls might still upend the unprepared investor's portfolio -- especially interest rate risk.

In evaluating your portfolio for potential vulnerability to surging rates, you'll want to examine your holdings' potential downside and upside risks. You'll stand the best chance of beating the market if you avoid stocks that higher rates will hurt, and own stocks with the strength to survive even the harshest investment landscapes.

One especially risky sectorMortgage REITs -- that's short for real estate investment trusts -- make their money by borrowing at short-term rates to buy real estate-related securities. They use the proceeds from their purchases to run the business and pay dividends to shareholders. The government allows these entities to pay no income tax, so long as they pay out more than 90% of their income as dividends to shareholders.

Low-rate environments allow these companies to load up on debt to easily finance their operations. However, higher interest rates should certainly apply greater pressure to these companies' massive payouts. If that scenario proves true, mortgage REIT companies like Chimera Investment and Annaly Capital Management could encounter serious headwinds. In fact, both Annaly and Chimera recently cut their dividend payouts, suggesting that my grim scenario might happen sooner than expected.

An interest rate-proof investmentOn the flip side, stocks that stand the best chance of thriving with higher rates should have strong balance sheets, established businesses, and have a healthy history of profitability, even during trying times. In this regard, well -known but still cheap blue chips look like they have what it takes to weather any market condition, while retaining sufficiently attractive valuations to make them worthwhile investments today. Here's how a few major players stack up in several key metrics:

Company Name

Market Cap (in billions)

P/LTM Diluted EPS (before extra)

Dividend Yield (%)

Cash & ST Investments (in billions)

Total Debt / Equity (%)

Johnson & Johnson(NYSE: JNJ)

$163.8

12.5

3.59%

$37,658

29.6%

Microsoft(Nasdaq: MSFT)

$216.6

11.0

2.5%

$36,559

20%

Chevron(NYSE: CVX)

$219.5

11.5

2.66%

$17,070

10.8%

Intel(Nasdaq: INTC)

$106.1

9.81

3.72%

$21,885

4.66%

ConocoPhillips(NYSE: COP)

$116.9

10.5

3.31%

$11,521

41.4%

Royal Dutch Shell(NYSE: RDS-A)

$233.3

10.8

4.56%

$13,444

29.6%

AstraZeneca(NYSE: AZN)

$66.8

8.22

5.34%

$12,550

39.4%

Source: Capital IQ, a division of Standard & Poor's.

With extremely favorable debt burdens and ample, almost excessive, cash waiting in the wings, these companies won't bat an eye when interest rates increase. Better yet, they offer tempting valuations and payouts right now. You'll get a safe and attractively priced stock today, while helping to ensure that your portfolio stays afloat in case times grow worse.

Smart investors always move proactively to benefit from changes as they occur. The last three years saw interest rates reach their lowest levels ever, and have yet to budge much since. Clearly, they have only one direction to go: Up! The Federal Reserve's easy-money policies brought plenty of contention when originally introduced. Now, given some of the comments issued recently by Fed members, rates may rise sooner than many observers expect.

A normal rate environment won't return overnight. However, a return to higher rates seems more of an inevitability than a possibility. Rest assured -- when those rates do rise, you'll want to make sure your portfolio's prepared.